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Question of the Week - March 13, 2017

Question of the Week - March 13, 2017

Guest Post - Monday, March 13, 2017

Is the bull market really 8 years old?

It doesn't seem that long ago, but stock markets just celebrated an 8-year anniversary from the market lows hit on March 9, 2009, when sentiment hit a trough during the Great Recession. Since that time, the S&P 500 price index has moved from 677 to 2,373, which, when adding back in dividends, accounted for a +316% cumulative total return (over 19% on an average annualized basis). Interestingly, it has been considered one of the least-loved bull markets in some time, as many investors seemed to have been skeptical from the start, and only recently have shown signs of optimism with hopes for improvement from the political side in the tax and regulatory environment, as well as hoped-for fiscal spending on defense and infrastructure.

During the last eight years, it's estimated that a recovery in price multiples (such as P/E) accounted for just under three-quarters of the market increase, while fundamental earnings growth represented just over a quarter. This isn't surprising, considering the bout of earnings challenges in a variety of sectors since the recession, and that markets have tended to react before conditions fundamentally improve. By contrast, in latter stages of a bull market, as market multiples are far higher, market growth has typically been driven by earnings growth and adjustments in earnings expectations. This isn't necessarily a negative message. While increases in price ratio are the 'easy money' in market recoveries, the earnings growth component can be far more durable and longer-lasting. For example, taking conservative earnings growth of +5% added to an implied dividend yield of +2% could result in a +7% total return (give or take a percent or two for market valuation adjustments). While below the long-term market average of +10% per annum, such a result would still respectable and far above results expected of bonds, where multi-year total returns are closely tied to starting yields (currently low).

Over time, it has been rare for bull markets to simply end due to 'old age' or 'fatigue'. Often, they form in a rut of extreme pessimism, move into a phase of skepticism, and, eventually, into the optimism and finally, exuberance. Investor behavior is often depicted in the visual form of a sine wave marked by positive and negative emotional overreactions, which behavioral finance practitioners claim is imprinted into human behavior. When emotional highs are eventually reached, there becomes little buffer against bad news when everyone's a buyer and there are fewer natural sellers. When we mean 'everyone', we're reminded of the story of Joe Kennedy, Sr. in the late 1920's (legendary investor, and father of JFK), who assumed a market peak when he received a stock tip from a shoe-shine boy. If not quite the case today, such markers are common and interesting in hindsight.

Of course, it's easy to get wrapped up in the high-profile anniversaries and milestones for U.S. equities. There are other stock markets in the world (Europe, emerging markets, etc.), which provide additional opportunities, which can be especially compelling when they fall in their own stage of skepticism and often-accompanying lower valuations.

Read our Weekly Review for March 13, 2017.

Read the previous Question of the Week for March 6, 2017.

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